Developments in fixed income markets over the past several years have intensified the need to re-examine core fixed income portfolios. A confluence of significant events — the subprime crisis in the summer of 2007, the failure of several important US financial institutions in 2008, and the subsequent Federal Government response — set the stage for a challenging market environment. As a result, some fixed income sectors experienced unprecedented and uncharacteristic volatility in 2008 and 2009, as investors faced poor active manager performance, the failure of diversification among bond markets, and severe illiquidity.
Although we could spend pages analyzing these events and their impact on fixed income, in this paper we look ahead to a new investment framework. In doing so, we question traditional investment techniques and embrace an objectives-based approach to bond investing that moves away from a focus on benchmarks in favor of disaggregating the components of core bonds.
Fixed income instruments are essential to institutional portfolios. Through an objectives-based approach, they can play a role in each step of the asset allocation and investment process. We believe that a focus on the roles that different fixed income instruments can provide in a portfolio will enable investors to build more effective investment programs.